Here’s Why Visa, MasterCard Should Be Very Worried About Amazon Coins

Virtual currencies have been around for almost 15 years now, but have only recently started getting attention from regulators and business analysts alike. Are they legitimate? Are they a profitable business model?

One of the larger firms to join the fray recently is Amazon (NASDAQ:AMZN), which launched its own virtual currency, Amazon Coins, last month. To most people, this seems like yet another virtual wallet with limited scalability. Many analysts have already drawn parallels between Amazon Coins and Facebook’s (NASDAQ:FB) failed virtual currency, Facebook Credits.

While in its current form Amazon Coins does seem to be very similar to Facebook Credits, assuming that it will stay that way is gravely underestimating Amazon and its need to increase margins. Knowing Amazon history of piloting initiatives before launching them all out, Amazon Coins just may be Amazon’s first step towards setting up its own payments network.

Amazon Coins has the potential to be much more than a virtual wallet as it complements Amazon’s strengths and its strategy. Amazon is in the business of retail where each transaction involves a ‘payments’ cost and, given its thin margins, bringing down those costs is critical for the company. Currently, almost 1 percent of Amazon’s total revenues go towards paying fees to card issuers and networks. That is at least $0.75 billion in costs for Amazon in 2013. Looking at how eBay (NASDAQ:EBAY) has built Paypal into a $5.1 Billion business that grew by 26 percent last year alone, it is evident that there are benefits to both the revenue and the cost side of the business if Amazon creates an alternate payment system.

To understand how Amazon would do this, you need to first understand what Amazon is creating. In its current form, Amazon Coins is nothing but a virtual wallet, where the currency is only limited by the number of merchants that accept it. Although Coins can initially be used only for media purchases on Kindle, I believe that Amazon will gradually get other online and offline merchants to start accepting Coins as a mode of payment. Amazon is already offering deals at brick and mortar establishments through AmazonLocal and it won’t be too tough for it to get these merchants and LivingSocial’s merchant partners to accept Coins as a mode of payment.

This would be an almost inevitable extension of Coins as it seamlessly fits into Amazon’s focus on reducing costs, its increasing involvement with offline retailers through AmazonLocal and its ability to leverage the merchant network of LivingSocial.

Alternately, Amazon could even tie up with a network like American Express (NYSE:AXP), which probably has a huge overlap with the Prime subscriber base, to scale up the acceptance of Coins across the Amex merchant network. If Amazon manages to get even 10 percent of its revenue in 2014 through purchases using Amazon Coins on Amazon.com alone, it is projected to save over $100 Million in payments costs.

This potential threat should raise serious concerns for Paypal, card issuers and networks like Visa (NYSE:V) and MasterCard (NYSE:MA), given how it may directly impact their businesses. Amazon already accounts for almost 26 percent of all U.S. e-commerce sales and if it starts processing these sales directly, Visa and Mastercard have a lot to lose. So does Paypal if Amazon gets most merchants to start accepting Coins as a mode of payment. And if I were any of these firms, I would start planning accordingly.

Puneet Dixit is a payments and e-commerce expert working with McKinsey & Company in New York City.